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Assignments of equipment lease payment streams were loans, not sales

The Bankruptcy Appellate Panel of the Ninth Circuit has ruled that assignments of equipment lease payment streams were not automatically perfected. Because the debtor failed to perfect the assignees’ interests in the payment streams, the bankruptcy trustee could bring an action to avoid those interests.

Commercial Money Center, Inc. (“CMC”) leased equipment to lessees with subprime credit. CMC then packaged groups of leases together and assigned its contractual rights to future lease payments to entities such as Net.B@nk, Inc., FSB (“NetBank”). CMC also obtained surety bonds guaranteeing the payments and assigned its rights under the bonds to NetBank. In addition, CMC granted NetBank a security interest in the underlying leases and other property.

CMC assigned NetBank an interest in the payment streams as well as the underlying leases, but it separated the two interests, the court summarized. In exchange, CMC received more than $47 million in transactions involving 17 pools of leases. Seven lease pools were at issue in the instant case.

CMC was required to perfect its own security interest in the leased equipment. It also was supposed to list NetBank in financing statements and lease documents as the “assignee” of those security interests; indicate NetBank’s interests on the lease documents; and deliver to NetBank evidence that it had filed financing statements and obtained the Surety Bonds.

After CMC filed for bankruptcy, the chapter 7 trustee filed a complaint seeking declaratory relief and avoidance of NetBank’s interests. He alleged that the debtor did not fulfill its obligations to perfect NetBank’s interests in the payment streams, and that NetBank did not satisfy the requirements for perfection either.

The Nevada UCC requires two conditions for automatic perfection to apply: (1) the payment streams must be payment intangibles; and (2) the transaction must be a sale.

The bankruptcy court ruled that the payment streams were “chattel paper” and therefore NetBank was required to perfect its interests under the rules applicable to chattel paper. The court ruled, in the alternative, that even if the payment streams were not chattel paper, NetBank could not benefit from the automatic perfection rule applicable to sales of payment intangibles because the transactions at issue were loans.

Payment Intangibles

The Ninth Circuit BAP disagreed with the bankruptcy court on the first issue, and held that the payment streams were payment intangibles, not chattel paper.

The UCC “defines chattel paper to mean the ‘records’ that ‘evidence’ certain things, including monetary obligations,” the court stated. “Payment streams stripped from the underlying leases are not records that evidence monetary obligations— they are monetary obligations.

“Therefore, we agree with NetBank that the payment streams are not chattel paper,” the court concluded.

Sale or Loan

The court next addressed whether the assignment of the payment streams were loans or sales, and agreed with the bankruptcy court that the transactions amounted to loans.

“Whether a transaction is a sale or a loan is based on the intentions of the parties as ‘determined from all the facts and circumstances surrounding the transactions at issue,’” the court stated.

NetBank cited numerous alleged characteristics indicating that each transaction was a sale.

However, “despite NetBank’s arguments, the transactions bear far more hallmarks of a loan than a sale,” the court concluded.

These included the requirement that CMC pay NetBank a minimum fixed amount, plus any additional interest and principal amounts owing to NetBank, regardless of what was paid by the lessees. The debtor also bore all the costs of collection from the lessees, and NetBank paid no fees for this expense or any other costs of servicing the leases.

“In other words, NetBank (1) has none of the potential benefits of ownership and (2) is contractually allocated none of the risk of loss,” the court stated.

CMC Misdeeds

NetBank also contended it would be inequitable to permit the trustee to benefit from CMC’s failure to perfect on behalf of NetBank. “This is a red herring,” the court responded. “NetBank is a sophisticated commercial entity and nothing prevented it from verifying that financing statements had been filed, or from taking possession of the leases.”

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